A commodity trade is a financial transaction involving the exchange of a raw or primary product between a seller and a buyer at an agreed price. Commonly traded commodities are agricultural products, including items like cattle, sugar, and wheat; petroleum products, including either crude oil or refined products; and precious and basic metals. Commodity trades are mostly conducted on regulated exchanges.
Exchanges define highly standardized contracts designed to facilitate trading. They also enforce a margin system, which requires participants to maintain a defined level of financial reserves in order to promote the performance of the trade and, more broadly, protect the overall integrity of the market. Exchanges act as a clearing house to guarantee the performance of all trades in the event that either the buyer or seller fails to comply with the contract. Commodity markets are global in nature, with price movements in the price of a commodity on one exchange being rapidly reflected in all other exchanges for that same commodity around the world.
Even though various forms of a commodity trade can be traced back many centuries to ancient times, modern commodities trading can began with the trading of agricultural products in the United States during the 19th century. Indeed, modern organized commodity trading is widely considered to have started with the opening of the Chicago Board of Trade (CBOT) in 1848. Futures contracts involving agricultural products began to be traded on CBOT by the 1860s.
A commodity trade may be conducted in either a spot, or physical, market or a derivatives market. Over recent years, the growth of commodity trades involving derivative instruments, or securities, has far outpaced that of spot transactions. Derivative securities include forward contacts futures contracts and options. Generally speaking, most commodity trading is based on derivatives, particularly futures contracts.
In participating in a commodity trade, the purpose of the buyer and seller may be to either assume risk — speculate — or to transfer — hedge — risk. A commodity trade may reflect both the buyer and the seller seeking to speculate or to hedge, depending on their respective views of the future. It is impossible to determine whether a trader’s purpose in conducting a commodity trade is to speculate or hedge. That depends critically on the trader’s opening financial position which is a private matter not normally visible to or known by anyone other than the trader.
